| The Futures/Intermarket Report, June 15, 2007 |
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| Written by Matt Caruso CMT | |
| Sunday, 17 June 2007 | |
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The Futures / Inter Market ReportTrading the World’s MarketsJune 15, 2007 Matthew Caruso, CMT We are preparing a big stock issue next week and this week we devote the newsletter to all the Dads out there. Matt Caruso explains the important Oil-Gas relationship and the part energy prices play on markets. Energy prices also impact the general economy – the more money consumers spend on energy, the less money they have for other purchases like shopping trips to the mall. And since consumer spending accounts for more than 70% of the U.S. economy, anytime energy more expensive it is bound to have a negative impact on other sectors. If the discussion gets too technical for you, simply cut to the conclusion that will outline what Matt is saying in non-trading terms. Making the most out of the energy sector à the Oil-Gas Spread TradeGasoline futures have embarked on a major bull market rally in recent months. The July RBOB gasoline futures contract has risen from $1.59 to $2.44, a 53.5% increase in a span of only 4 months. Anyone holding a single gas contract for that run would have made over $30,000. Crude oil traders have experienced a rise in the price of crude as well over the last 4-5 months, albeit a less aggressive run up having made only a 29.4% gain. One of the major reasons for this large run up in gasoline is that a number of gas refineries have been unable to process crude thus increasing crude stocks at the expense of gasoline. Crude and gasoline both rose off their January bottoms, but gasoline traders have received a greater bang for their buck, leaving many traders long crude oil wishing they had bought gasoline instead. Chart readers could have seen this divergence between crude and gas coming; in fact it happens almost every year. The method of comparing two securities in order to find the relative leader is called comparative relative strength. It is simply dividing the price of one security by another in order to see which has been out performing. Figure 1 shows crude oil and gasoline prices in the bottom panel of the chart and the comparative relative strength of crude oil / gasoline in the top panel. It is clear that despite the strong bull market in both commodities, there are times when one commodity significantly outperforms the other.
 Figure 1
The relative strength is range bound and has a tradable upper and lower limit. This means that traders have a reference point to indicate when crude has advanced too far ahead of gasoline and vice versa, this is clearly indicated in figure 2 by the blue lines near the upper and lower boundaries of the relative strength line. Figure 2 shows the same relative strength (RS) as figure 1 in the bottom panel but also shows the detrended (or smoothed) relative strength in the upper panel. Every time the detrended RS approached the overbought area, crude began to under perform gas, and every time the detrended RS approached the oversold area, crude oil then began to outperform gas. Not only does this pattern trade within a defined range, it has a seasonal pattern as well. A number of tops and bottoms are outlined in Figure 2 and show the seasonal tendency for crude to begin underperforming gas in the fall months, and to start outperforming gas in the late spring / early summer time period.
Figure 2 This information is crucial to any traders trading the energy markets, or markets related to it such as energy stocks. Anyone wanting to buy into the energy sector in the fall would typically be best off buying gasoline futures or stocks related to gasoline and refining. Anyone wanting to buy into the energy sector in the spring time would typically be best off buying crude oil or stocks highly correlated to the price of it. Traders wanting to short the energy sector would typically be best off doing the opposite. Traders have another option as well which is called spread trading. This approach would have traders buy gasoline futures in the fall while shorting crude at the same time. This would allow traders to make money off gasoline’s tendency to outperform cruse at this time of year regardless to what direction the commodities move in. The reason is that if prices rise, the gasoline futures would appreciate quicker than crude leaving the trader excess profits. If prices fall, the crude will depreciate by a greater amount than gasoline still leaving the trader a profit. It seems the energy markets are following their typical pattern this year as well. crude began to under perform gasoline starting from September 8th of 2006 and did so for the entire gasoline run up that started in January, as can be seen in figure 2. As well, now that summer is here, crude has begun to out perform gasoline once again and if the typical seasonal pattern repeats this year crude will continue to outperform gasoline until this fall. As previously mentioned, this affects not only futures traders, but stock traders as well. Fig 3 shows Valero (VLO - refiner), Exxon Mobile (XOM - Oil exploration & production) and their relative strength line (XOM / VLO). As you can see XOM outperformed VLO starting last summer up until December when VLO began to outperform. Although both stock climber this spring, stocks traders would have benefited by being long VLO rather then XOM. This pattern can benefit stock traders, futures traders as well as spread traders. If you are gong to invest in energy, this pattern can help you get the largest possible return by being in the part of the energy sector that will move most favorably in your anticipated direction.
Figure 3 So where are we now?In wrapping up the comparison between oil and gas, assuming this historic relationship continues as it has in the past, it’s a better time to own oil or oil stocks compared to gasoline. And as we see from Figure 4, oil looks (and oil stocks) look to be a buy relative to the S&P500. Figure 4 – Chart showing price of oil relative to stocks (S&P500). On a relative basis oil looks to be at the cheaper end of its range. Chart by Metastock.com ------------------------------------------------------------------------------------------------------------------------------------------ DisclaimerTradeSystemGuru.com obtains information from sources deemed to be reliable; |
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| Last Updated ( Tuesday, 10 July 2007 ) |
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